Innoviva is a specialty finance company that was spun out of a biotech company. This company is a royalty collector on assets (Breo, Anoro, Trelegy) that were developed in collaboration with GSK. It is essentially a virtual company with 5 employees, a little net cash, and a large royalty stream.
This is a low risk/modest return "runoff" trade. To me it's attractive because of the steep skew and idiosyncacy in a high valuation market.
Thesis:
NPV of royalties worth 30% more than stock price. The company is runrating ~$250M of FCF and has an EV of $1.2B. The royalties should last around 7-8 years (royalties last for 15 years after launch in each country) and assuming they stay flat (hard to know, reasonable base case) the stock is pricing in ~$500M of discounting/value destruction. While the drugs have faced pressure in the US, they continue to grow OUS. On net, they have been flat/up since launch. Additionally, the US weakness has been predominantly price, so there is logically a lower asymptote that should eventually drive stability in the US.
Capital allocation now clear. The company began as a levered entity with growing cash flows. It is now a net cash company with stable cash flows. The company has been migrating to an investment manager model (terrible, I know). First, they wrote ~$75M into two risky biotechs (I ascribe no value). Now, they just announced a $300M investment as an LP into Sarissa Capital (the activist that drove change at the company). While the Sarissa investment may/may not generate returns, it appears that all the cash flow will now eventually end up as financial assets and the company is trading at ~30% discount to that NAV.
High skew. In a world of 20x revenue world beaters, this is a knuckle dragger but you get $1 for $0.70. The company is optically trading for 6x FCF and that cash flow has high near term visibiity. While the multiple may not expand, it seems difficult for it to compress as the financial assets pile up on the balance sheet. I'm not sure what is the end game here, but at least the company will not be directly burning shareholder capital like most biotechs.
Risks:
Erosion of royalty streams. While the royalties continued to grow in 2020, some of that appears to be a reversal of price concessions from 2019. Assuming a return to price erosion it is possible that the royalty revenues decline. That said, GSK consensus is projecting flattish numbers going forward. There is another risk that volumes shift between products and create negative mix. The company gets 15% off Breo, but only 1-2% off Trelegy.
Poor capital allocation. The bets placed on the anti-inectives companies (Armata, Entasis) seem high risk/modest reward. They probably fail, and even if they work it's not a very attractive category. The main concern is that they keep burning shareholder capital on risky bets. However, the Sarissa LP investment will be with a credible manager and hopefully make a decent return (no leverage, no shorting) on a portfolio of long stock positions. The terms are 1%/10% with a MFN clause. I'm not saying it's good, but I am saying it's not as bad as the market is pricing.
Durable discount to NAV. Given the 3-year lockup on the Sarissa investment and the highly illiquid anti-infective equities, the portfolio should trade at a discount to NAV. However, I'd guesstimate that NAV right now is worth ~$1.8B ($250M x 7 years + $75M equities). It seems reasonable to me to pay at least 90% of that NAV while we figure out how it all plays out.
Valuation:
My simple math is current FCF of ~$250M should last for ~7-8 years. Assuming reasonable capital allocation, the company should trade at a modest discount to NAV. I'll say ~$15/share (~$1.5B)
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
1) Continued stability to royalty revenues. The market may care if they can maintain 2020 performance or even grow royalties.
2) LP portfolio performance. If the Sarissa portfolio were to perform it would create even greater tension on the discount to NAV.
3) Clinical trial results from anti-infective programs. I have no view here, but if a program were to work the company could generate some decent profits vs the EV.
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